7 things you may not know about IRAs

Make sure you aren't overlooking some strategies and potential tax benefits.

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Key takeaways

  • IRAs are available to nonworking spouses.
  • IRAs allow a "catch-up" contribution of $1,000 for those 50 and up.
  • IRAs can be established on behalf of minors with earned income.

It's the time of year when IRA contributions are on many people's minds—especially those doing their tax returns and looking for a deduction. The deadline for making IRA contributions for the 2018 tax year is April 15, 2019. Residents of Massachusetts and Maine have until April 17, 2019 to make 2018 IRA contributions.

Chances are, there may be a few things you don't know about IRAs. Here are 7 commonly overlooked facts about IRAs.

1. A nonworking spouse can open and contribute to an IRA

A non-wage-earning spouse can save for retirement too. Provided the other spouse is working and the couple files a joint federal income tax return, the nonworking spouse can open and contribute to their own traditional or Roth IRA. A nonworking spouse can contribute as much to a spousal IRA as the wage earner in the family. For 2018 the IRA contribution limit is $5,500, or $6,500 for those over age 50. For 2019, the limit is $6,000, or $7,000 if you're over 50. The amount of your combined contributions can't be more than the taxable compensation reported on your joint return.

2. Even if you don't qualify for tax-deductible contributions, you can still have an IRA

If you're covered by a retirement savings plan at work—like a 401(k) or 403(b)—and your 2018 or 2019 modified adjusted gross income (MAGI) exceeds applicable income limits, your contribution to a traditional IRA might not be tax-deductible.1 But getting a current-year tax deduction isn't the only benefit of having an IRA. Nondeductible IRA contributions still offer the potential for your money and earnings to grow tax-free until the time of withdrawal. You also have the option of converting those nondeductible contributions to a Roth IRA (see No. 7, below).

3. After 2018, alimony will not count as earned income to the recipient

Unless the new tax rule changes, you will likely not be able to use money received as alimony to fund an IRA after tax year 2018.

That's due to changes in the law introduced by the Tax Cuts and Jobs Act of 2017: After 2018, alimony payments will no longer be considered taxable income to the recipient—and the source of IRA contributions must be taxable earned income.

4. Self-employed, freelancer, side-gigger? Save even more with a SEP IRA

If you are self-employed or have income from freelancing, you can open a Simplified Employee Pension plan—more commonly known as a SEP IRA.

Even if you have a full-time job as an employee, if you earn money freelancing or running a small business on the side, you could take advantage of the potential tax benefits of a SEP IRA. The SEP IRA is similar to a traditional IRA where contributions may be tax-deductible—but the SEP IRA has a much higher contribution limit. The amount you, as the employer, can put in varies based on your earned income. For SEP IRAs, you can contribute up to 25% of any employee's eligible compensation up to a $55,000 limit for 2018 contributions and $56,000 for 2019. Self-employed people can contribute up to 20%2 of eligible compensation to their own account. The deadline to set up the account is the tax deadline—so for 2018 it will be April 15, 2019 (for a calendar-year filer). But, if you get an extension for filing your tax return, you have until the end of the extension period to set up the account or deposit contributions.

5. "Catch-up" contributions can help those age 50 or older save more

If you're age 50 or older, you can save an additional $1,000 in a traditional or Roth IRA each year. This is a great way to make up for any lost savings periods and make sure that you are saving the maximum amount allowable for retirement. For example, if you turn 50 this year and put an extra $1,000 into your IRA for the next 20 years, and it earns an average return of 7% a year, you could have almost $44,000 more in your account than someone who didn't take advantage of the catch-up contribution.3

6. You can open a Roth IRA for a child who has taxable earned income4

Helping a young person fund an IRA—especially a Roth IRA—can be a great way to give them a head start on saving for retirement. That's because the longer the timeline, the greater the benefit of tax-free earnings. Although it might be nearly impossible to persuade a teenager with income from mowing lawns or babysitting to put part of it in a retirement account, gifting money to cover the contribution to a child or grandchild can be the answer—that way they can keep all of their earnings and still have something to save. The contribution can't exceed the amount the child actually earns, and even if you hit the maximum annual contribution amount of $6,000 (for 2019), that's still well below the annual gift tax exemption ($15,000 per person in 2018 and 2019).

The Fidelity Roth IRA for Kids, specifically for minors, is a custodial IRA. This type of account is managed by an adult until the child reaches the appropriate age for the account to be transferred into a regular Roth IRA in their name. This age varies by state. Bear in mind that once the account has been transferred, the account's new owner would be able to withdraw assets from it whenever they wished, so be sure to educate your child about the benefits of allowing it to grow over time and about the rules that govern Roth IRAs.

7. Even if you exceed the income limits, you might still be able to have a Roth IRA

Roth IRAs can be a great way to achieve tax diversification in retirement. Distributions of contributions are available any time without tax or penalty, all qualified withdrawals are tax-free, and you don't have to start taking required minimum distributions at age 70½.5 But some taxpayers make the mistake of thinking that a Roth IRA isn't available to them if they exceed the income limits.6 In reality, you can still establish a Roth IRA by converting a traditional IRA, regardless of your income level.

If you don't have a traditional IRA you're still not out of luck. It's possible to open a traditional IRA and make nondeductible contributions, which aren't restricted by income, then convert those assets to a Roth IRA. If you have no other traditional IRA assets, the only tax you'll owe is on the account earnings—if any—between the time of the contribution and the conversion.

However, if you do have any other IRAs, you'll need to pay close attention to the tax consequences. That's because of an IRS rule that calculates your tax liability based on all your traditional IRA assets, not just the after-tax contributions in a nondeductible IRA that you set up specifically to convert to a Roth. For simplicity, just think of all IRAs in your name (other than inherited IRAs) as being a single account.

Read Viewpoints on Fidelity.com: Answers to Roth conversion questions

Next steps to consider

Take advantage of potential tax-deferred or tax-free growth.

Determine which IRA may make sense for you.

This small percentage can add up to a lot in retirement.

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Investing involves risk, including risk of loss.

1.

For a Traditional IRA, for 2018 full deductibility of a contribution is available to active participants whose 2018 Modified Adjusted Gross Income (MAGI) is $101,000 or less (joint) and $63,000 or less (single); partial deductibility for MAGI up to $121,000 (joint) and $73,000 (single). In addition, full deductibility of a contribution is available for working or nonworking spouses who are not covered by an employer-sponsored plan whose MAGI is less than $189,000; and partial deductibility for MAGI up to $199,000. For 2019 full deductibility of a contribution is available to active participants whose 2019 Modified Adjusted Gross Income (MAGI) is $103,000 or less (joint) and $64,000 or less (single); partial deductibility for MAGI up to $123,000 (joint) and $74,000 (single). In addition, full deductibility of a contribution is available for working or nonworking spouses who are not covered by an employer-sponsored plan whose MAGI is less than $191,000; and partial deductibility for MAGI up to $201,000. If neither you nor your spouse (if any) is a participant in a workplace plan, then your Traditional IRA contribution is always tax deductible, regardless of your income.

2. Of net self-employment income reduced by half of self-employment tax.
3. This hypothetical example is for illustrative purposes only and is not intended to represent the performance of any security in a Fidelity IRA. The example assumes annual tax-deferred compounding in an IRA; that annual contributions are made each January 2 for 20 years; an annual contribution limit of $5,500; a hypothetical 7% annual return; and the reinvestment of income dividends and capital gains distributions. Assumes additional "catch-up" annual limits of $1,000. Investing in this manner does not ensure a profit or guarantee against loss. Final account balances are prior to any distributions, and taxes may be due upon distribution. Investments that have potential for a 7% annual rate of return also come with risk of loss.
4. In general, anything that can be legitimately reported as taxable income on a Form W-2 is acceptable (although the fact that the income is taxable doesn't necessarily mean that taxes are paid—the amount could be below the child's exemption). So money a child earns on a paper route is OK, but money given to him or her by his or her parents as an allowance probably isn't. Money earned by a child employed in a family business may be acceptable, but documentation will be required and the amounts must be reasonable—you wouldn't be able to claim to have paid your 10-year-old $300 for one hour of sealing envelopes. Always consult with a tax advisor when in doubt.
5.

A distribution from a Roth IRA is tax free and penalty free, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, qualified first-time home purchase, or death.

6. For 2018, if you're single the ability to contribute to a Roth begins to phase out at MAGI of $120,000 and is completely phased out at $135,000. If you're married filing jointly, the phaseout range is $189,000 to $199,000 for 2017. For tax year 2019, if you're single, the ability to contribute to a Roth IRA begins to phase out at MAGI of $122,000 and is completely phased out at $137,000. If you're married filing jointly, the phaseout range is $193,000 to $203,000.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

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